Case 078Reading financialsCore

Chitrav Apparel's EBITDA rose 25% but its operating cash flow nearly disappeared. Receivable and inventory days both jumped and a new distributor on 120-day terms now takes 30% of sales. What is happening, and what EBITDA would you underwrite?

The situation

Chitrav Apparel, a branded clothing company, is for sale. Revenue grew from Rs 400 crore to Rs 500 crore and EBITDA from Rs 80 crore to Rs 100 crore, a steady 20% margin. Operating cash flow went the other way: about Rs 60 crore last year, about Rs 3.5 crore this year.

Receivable days rose from 60 to 95 and inventory days, measured on cost of goods sold at 50% of revenue, from 70 to 90. Payable days held at 60. This year Chitrav signed a new distributor on 120-day payment terms, and that distributor took 30% of sales. Tax is about Rs 12 crore last year and Rs 17 crore this year.

Your task

Explain the gap between profit and cash with numbers, and say what EBITDA a buyer should underwrite.

Quick check

Before working it: how much of the 25% EBITDA growth would you take at face value?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Underwrite about Rs 70 crore, not Rs 100 crore. Working capital absorbed Rs 79 crore this year, so operating cash flow fell to about Rs 3.5 crore. The new distributor bought Rs 150 crore on 120-day terms while sales to everyone else shrank to Rs 350 crore. At a 20% margin the core earns about Rs 70 crore; the distributor's share counts only once its invoices turn into cash.

Step 1Where did the cash go?

Start with the bridge from EBITDA to cash, because the gap has to sit somewhere. Operating cash flow is EBITDA less tax less the increase in working capital, and this year working capital ate Rs 79 crore of a Rs 100 crore profit. Receivables rose from Rs 65.8 crore to Rs 130.1 crore, inventory from Rs 38.4 crore to Rs 61.6 crore, and payables only from Rs 32.9 crore to Rs 41.1 crore. Think of a tailor who doubles orders by letting a new shop take suits on four months' credit: the order book looks great and the till is empty.

Chitrav's EBITDA rose from Rs 80 crore to Rs 100 crore, but the working capital build grew from Rs 8 crore to Rs 79 crore, so operating cash flow fell from about Rs 60 crore to about Rs 3.5 crore.

Rs crore	Year 1	Year 2	Change
Receivables (60 then 95 days of revenue)	65.8	130.1	64.4
Inventory (70 then 90 days of cost of goods)	38.4	61.6	23.3
Payables (60 days of cost of goods)	32.9	41.1	8.2
Working capital tied up	71.2	150.7	79.5

Net working capital grew by Rs 79.5 crore in one year, almost four fifths of the year's EBITDA, and receivables alone account for Rs 64.4 crore of it.

Step 2Is the distributor the whole story?

Not quite, and the split matters for diligence. If only the distributor paid slowly, blended receivable days would be 78, not 95; the other 17 days mean the old customers are paying later too. The distributor owes about Rs 49 crore. That leaves Rs 81 crore owed by core customers on Rs 350 crore of sales, about 84 days against 60 a year ago. Slower collections from existing customers often mean the sales team is buying volume with credit, which is a quality of earningsHow far reported profit reflects repeatable, cash-backed business rather than one-offs, accounting choices or sales pulled forward. question for the buyer's accountants.

Of the Rs 64 crore rise in receivables, about Rs 49 crore is the new distributor on 120-day terms and about Rs 23 crore is core customers stretching from 60 to roughly 84 days.

Step 3What EBITDA would you underwrite, and what would change your mind?

Separate what is proven from what is not. Core sales fell from Rs 400 crore to Rs 350 crore, and at the company's 20% margin they earn about Rs 70 crore, below last year's Rs 80 crore. The distributor's Rs 150 crore of sales carries about Rs 30 crore of EBITDA, but there is no evidence yet that it sold the clothes on to shoppers. Ask for three things: the distributor's sell-through and stock on hand, the first collections against its 120-day invoices, and any return rights in the contract. If the stock is moving and the cash arrives, add the Rs 30 crore back.

Price it in the meantime. At an illustrative 10x multiple, underwriting Rs 70 crore instead of Rs 100 crore is a Rs 300 crore difference in enterprise value. The usual way to bridge it is an earn-out or a deferred payment tied to the distributor's collections, so the seller is paid for the growth when it proves real. The limit of this view: if the distributor is a genuine new channel, say a large retail chain, the slow first year is normal and the haircut is too harsh. The data room settles it, not the multiple.

Where candidates lose it

Most candidates say working capital went up, so cash fell, and stop. That describes the gap without explaining it. The marks are in splitting the revenue by customer and noticing that one new account bought more than the entire growth while the rest of the business shrank.

The second miss is blaming the distributor for all of the slower collections. The blended days only reach about 78 if the old customers held at 60; reaching 95 means they slowed too, which is a separate and worse signal.

What the interviewer asks next

The distributor has a right to return unsold stock. How would that change revenue recognition and your EBITDA?
Chitrav proposes to sell the distributor receivables to a factor. Does that fix the problem a buyer cares about?
What normalised working capital level would you set as the peg in the purchase agreement?
Which line of the cash flow statement would you check first next quarter?

Company names and figures are illustrative.